If you’re like most contractors, you started your business because you love building things. But the structures you assemble are only one side of the equation that leads to success in the industry. The other side of the equation is construction accounting.
Construction accounting helps you keep track of every dollar coming in and every dollar going out over the life of a project.
In this guide, we’ll discuss what makes construction accounting unique, the methods available for each project, and the best practices that can help you stay on the road to success.
Key Takeaways
- Job costing is the process of tracking every dollar associated with a specific construction project. It’s important in construction accounting because it determines the true profitability of each project, helps management make informed decisions about resources (e.g., pricing, bidding, and allocation), and allows for comparisons between estimated and actual costs, leading to better future bids.
- In the Completed Contract Method (CCM), revenue and expenses are recognized on the books only when the project is complete. The Percentage of Completion Method (PCM) recognizes revenue and expenses on the books as the project progresses. The choice between the two often comes down to the nature of the contract, the reliability of estimates, and the regulatory requirements in play (e.g., GAAP/IFRS and tax laws).
- Retainage is a practice that allows clients to hold back a portion of payments until project completion. It can sometimes create delayed revenue recognition and cash flow issues.
- Successful construction accounting relies on a variety of documents, including profit and loss (P & L) statements, balance sheets, cash flow statements, work-in-progress (WIP) reports, job costing reports, project status and progress reports, change order reports, equipment utilization reports, subcontractor reports, certified payroll reports, and accounts receivable (AR) and accounts payable (AP) aging reports.
What Is Construction Accounting?
Construction accounting is project-based financial management that focuses on tracking and analyzing costs, managing project budgets, monitoring cash flow, and ensuring compliance with industry-specific regulations.
Construction accounting is designed to help general contractors, subcontractors, project managers, and office administrators manage financial performance during long, multi-phase projects.
What Makes Construction Accounting Unique?
Long-Term, Irregular Projects
Unlike fixed, recurring revenue models, construction income is tied to contracts that may span months or even years.
Field-Based Production And Decentralized Teams
Crews, equipment, and costs may be distributed across multiple sites, making centralized tracking essential for everything from supplies and materials to hours worked and vehicle use.
Frequent Change Orders
Construction jobs are often fluid, and the scope of work can sometimes change mid-project. These change orders require real-time cost updates.
Retainage Practices
Retainage is a common practice in construction that allows clients to hold back a portion of the payments (usually 5-10%) until the project is complete. If not handled correctly, retainage can create delayed revenue recognition and cash flow issues.
Progress Billing
In construction accounting, invoicing is milestone-based. This is in sharp contrast to the time-based method common in regular accounting.
Cash Flow Volatility
Materials and labor costs can fluctuate wildly in the construction industry, making proactive job costing and budgeting essential.
Other Features
Construction accounting is different from regular accounting in a variety of other ways as well, including the way costs are tracked, how customers are billed, how payroll is run, and how compliance is managed.
Here’s a table to help you understand these differences.
Methods of Accounting for Construction
As you can see, construction is a complex business. If you don’t track income and costs closely, it might be difficult to tell whether you made any money once the project is finished. Construction accounting helps you see the whole picture.
Keep in mind that the method you choose affects a variety of variables, including your tax burden, compliance, and WIP reporting.
Cash Method
In the cash method, revenue is recognized when received and expenses are recognized when paid. The cash method is the simplest construction accounting method but is less accurate for most multi-phase projects.
Completed Contract Method (CCM)
In the Completed Contract Method (CCM), revenue and expenses are only recognized on the books when a project is complete. This can help delay tax liability but can also obscure real-time profitability.
Percentage Of Completion Method (PCM)
The Percentage of Completion Method (PCM) recognizes revenue and expenses as a job progresses. PCM aligns better with Generally Accepted Accounting Practices (GAAP), is the preferred method for larger companies, and makes cash flow forecasting and reporting easier.
8 Construction Accounting Best Practices
1) Understand The Construction Accounting Cycle
The construction accounting cycle is a continuous loop of activity that looks like this:
- A transaction happens (you buy materials, pay workers, or a client writes you a check)
- You record that transaction
- You post those transactions to the general ledger (the timing depends on whether you use the cash method, the Completed Contract Method, or the Percentage of Completion Method)
- You prepare financial statements and reports
- You analyze and adjust (both the project and the business itself)
Once you reach step five, you go back to step one and start again, sometimes several times a day.
2) Separate Business And Personal Finances
Keep your finances separate by opening a bank account and credit card that is just for business use. This helps you keep track of business expenses more accurately and makes tax prep at the end of the year much simpler.
3) Leverage Construction Management Software
Construction management software can be incredibly helpful for managing data entry, generating invoices and reports, and helping with payroll.
Couple that with an expense management platform like Coast that also integrates with regular accounting software like QuickBooks, NetSuite, and Sage Intacct, and you’ve got a powerful suite of tools that make construction accounting much easier.
4) Track Change Orders As They Happen
Change orders are a necessary part of the construction business, but they can throw a huge monkey wrench in your construction accounting if not tracked well.
Make use of software that allows you to track these changes in real time and gives you direct integration into your accounting software so that new expenses don’t get lost in the shuffle.
5) Implement Job Costing
With the help of unique ID numbers for each project, job costing allows you to categorize expenses (e.g., supplies, tools, labor, equipment usage) quickly and accurately, whether you’ve got one, three, or five or more projects in progress.
Implementing job costing helps you assess project profitability in real time and improve estimating for the next projects on your schedule.
It’s worth noting that you don’t have to wrestle with job costing on your own. Software like Coast can help.
When you or your team make purchases with the Coast card, the software can automatically tag each transaction with a job code or ID number for easier tracking, reporting, and overall management.
6) Get A Handle On Your Overhead Costs
Overhead costs are what it takes to keep your doors open and your lights on and include things like rent, utilities, office supplies, and other expenses.
You need to get a handle on these expenses so that you’re charging enough for each project to cover the basics.
7) Master Progress Billing And Retainage
Progress billing and Work In Progress reports (WIPs) make it easier to get paid for the work you’ve done in a certain period of time rather than waiting until the very end of the job.
It’s also important to master retainage (how much your clients are holding back) so that you know how much to expect at the end and when you’ll see those dollars on your general ledger.
8) Analyze Financial Reporting At Least Once A Month
Regardless of the projects you’ve got going on, take the time to analyze financial reporting at least once a month. Doing so is like comparing the blueprints to the work that’s already been done and can quickly tell you if you’re on the road to profit or loss.
Stay On Top Of Your Construction Accounting With Coast
Accurate, timely accounting is critical for keeping construction projects profitable. Tracking receipts, coding expenses, and reconciling accounts can slow you down. Coast is an all-in-one expense management platform and smart fleet card built for the way construction businesses work.
With Coast, you can:
- Assign every purchase to the right project or cost code in real time
- Set spending limits by category and block unauthorized merchants
- Eliminate paper receipts by prompting employees to snap a photo of their receipt as they spend
- Automate your transaction coding and categorization
- Export transactions effortlessly with your construction accounting software to speed up month-end close
Whether you’re managing crews across multiple sites or juggling fuel, material, and equipment expenses, Coast gives you the control and visibility to keep your books accurate and your jobs on budget.
To learn more about how Coast can help with all your accounting needs, visit CoastPay.com.
Frequently Asked Questions [FAQS]
Do I have to use construction accounting software?
No, you don’t have to use construction accounting software if you don’t want to.
What that means, however, is that you’ll have to run your job costing, project management, payroll, accounts payable/receivable, inventory, billing, and everything else by hand.
It also means you’ll miss out on a whole host of other useful features such as automation, project and accounting integration, access to real-time data, document management, regulatory compliance, and much more.
What are common construction accounting mistakes?
Common construction accounting mistakes include not tracking job costs, poor cash flow management, incorrect expense categorization, and delayed or inaccurate invoicing.
You can also run into problems if you don’t reconcile your accounts regularly, fail to separate personal and business expenses, and neglect keeping documentation of expenses and changes.
Should I hire a construction accountant or CPA?
You don’t have to hire a construction accountant or CPA, but it’s often a good idea. They understand the nuances of the construction industry that a general accountant might miss.
In addition, construction accountants or CPAs are often better able to help you maintain compliance, optimize financial performance, and provide deep insight and strategic advice.
All of that can be extremely beneficial for your business.
